Saudi Arabia’s planned IPO of around 5% of its national oil company, Aramco, has been causing considerable speculation in the press. An estimated 90% of the Aramco’s worth is based on its oil reserves valued at the current market price. Based on current oil price, this is a terrible time to be selling even a small percentage of this important asset. Why are the Saudis doing this?

There is talk of raising financing for various non-oil programmes but the main reason is that Saudi Arabia urgently needs cash. By the time of the proposed IPO the total budget deficit will be around 190 billion USD. In just two years this deficit will have eaten into 25% of the Saudi foreign exchange cash reserve. Government debt financing is an option, but since the credit rating agencies have been steadily downgrading the Saudi rating, this is not as attractive as going out to market with something.

At the current oil price, I calculate the value of 5% of Aramco to be approximately 220 billion USD. A sale now would cover the budget deficit, but the Saudis will want to get as much out of the sale as possible. Additional funds will give them something to show for the sale, which can then be invested on their other reform programmes, or meet their military spending commitments, for example.

Because of its vast reserves and lowest production cost, Saudi Arabia controls the minimum market value of oil in the global market place. Since they control the value of the commodity on which Aramco is built, the Saudis can control the value of the IPO.  My suggestion is that the Saudis will raise the global price of oil by constraining oil production close to the time of the IPO. This will raise the value of Aramco stock for the sale, giving the Saudis as much cash as possible. All things being equal, OPEC will be firmly on-side for these changes.

Saudi Arabia has been keeping oil prices low because it wants to keep new producers out of the global oil markets (e.g. U.S. shale), and to retain its market share. It also wants to repress Iranian oil production by hindering the investment Iran needs restart its oil industry. The timing of the IPO is an indicator of when Saudi Arabia believes the strategy has sufficiently paid off. If success comes earlier or later, then I believe that the date of the IPO will shift accordingly.